Anthropologists speak of the Copper Age, the Bronze
Age, and the Iron Age as steps or stages through which societies and cultures
pass in the course of their advancement toward becoming true civilizations. It
would appear we have entered the Kopper Age in accounting

Thomas C. Omer
Associate Professor Department of Accounting
University of Illinois At Chicago
The Art of Discovery: Finding the forest in spite of the trees.

An
Accounting Paradox:
When will accounting for an
asset destroy the asset?

Question:
Where were Enron's
intangible assets? In
particular, what was its
main intangible asset that
has been overlooked in terms
of accounting for
intangibles?
Answer
by Baruch Lev:

Baruch Lev Quote
from Page 131 (from
the reference above)

On December 31, 2000, Enron's market value was $75.2 billion,
while its book value (balance sheet equity) was $11.5 billion. The
market-to-book gap of almost $64 billion, while not equal to the value of
intangibles (it reflects, among other things, differences between current and
historical-cost values of physical assets), appears to indicate that Enron had
substantial intangibles just half a year before it started its quick slide to
extinction. This naturally raises the questions: Where are Enron's
intangibles now? And even more troubling: Why did not those intangibles--a
hallmark of modern corporations--prevent the firm's implosion? In
intangibles are "so good", as many believe, why is Enron's situation
"so bad"?

Baruch Lev Quite
beginning on Page
133 (from the
reference above)

So the answer to the question posed at the opening of this
note--where have Enron's intangible gone?--is a simple one: Nowhere. Enron
did not have substantial intangibles, that is, if hype, glib, and earnings
manipulation did not count as intangibles. Which, of course, also answers
the second question--why did not the intangibles prevent Enron's implosion.

Back to Greenspan's comment about the fragility of
intangibles: "A physical asset, whether an office building or an automotive
assembly plant, has the capability of producing goods even if the reputation of
the managers of such facilities falls under a cloud. The rapidity of
Enron's decline is an effective illustration of the vulnerability of a firm
whose market value largely rests on capitalized reputation."
Intangibles are indeed fragile, more on this later, but "true"
intangibles are not totally dependent on managers' reputation. IBMs
management during the 1980s and early 1990s drove the company close to
bankruptcy, and was completely discredited (though not ethically, as
Enron's). But IBMs intangibles--innovation capabilities and outstanding
services personnel--were not seriously harmed. Indeed, under Lou Gerster's
management (commencing in 1993), IBM made an astounding comeback.
Hypothetically, would a tarnished reputation of Microsoft, Pfizer, or DuPont's
management destroy the ability of these similarly innovative companies to
continuously introduce new products and services and maintain dominant
competitive positions? Of course not. Even when companies collapse,
valuable patents, brands, R&D laboratories, trained employees, and unique
information systems will find eager buyers. Once more, Enron imploded, and
its trading activities "acquired" for change not because its
intangibles were tied to management's reputation, but partly, because it did not
have any valuable intangibles--unique factors of production--that could be used
by successor managers to resuscitate the company and create value.

Finally, to the fragility of intangibles. As I elaborate
elsewhere,3 along with the ability of intangible assets to
create value and growth, comes vulnerability, which emanates from the unique
attributes of these factors of production:

Partial excludability (spillover): The inability of
owners of intangible assets to completely appropriate (prevent non-owners from
enjoying) the benefits of the assets. Patents can be "invented
around", and ultimately expire; trained employees often move to
competitors, and unique organizational structures (e.g., just-in-time
production) are imitated by competitors.

Inherently high risk: Certain intangible investments
(e.g., basic research, franchise building for new products) are riskier than
most physical and financial assets. The majority of drugs under
development do not make it to the market, and most of the billions of dollars
spent by the dotcoms in the late 1990s to build franchise (customer base) were
essentially lost.

Nonmarketability: Market in intangibles are in
infancy, and lack transparency (there are lots of patent licensing deals, for
example, but no details released to the public). Consequently, the
valuation of intangible-intensive enterprises is very difficult (no
"comparables"), and their management challenging.

Intangibles are indeed different than tangible assets, and in
some sense more vulnerable, due to their unique attributes. Their unusual
ability to create value and growth comes at a cost, at both the corporate and
macroeconomy level, as stated by Chairman Greenspan: "The difficulty of
valuing firms that deal primarily with concepts and the growing size and
importance of these firms may make our economy more susceptible to this type of
contagion". Indeed, intangible-intensive firms are "growing in
size and importance", a fact that makes the study of the measurement,
management, and reporting of intangible assets so relevant and exciting,
irrespective of Enron the intangibles-challenged sorry affair.

Answer
by Bob Jensen

I have to
disagree with
Professor Lev with
respect his
statement:
"
Enron did not have
substantial
intangibles."
I think Enron, like
many other large
multinational
corporations,
invested in a type
of intangible asset
that has never been
mentioned to my
knowledge in the
accounting
literature.
Enron invested
enormously in the
intangible asset of
political power and
favors. There
are really two types
of investments of
this nature for U.S.
based corporations:

Investments in
bribes and
political
contributions
allowed under
U.S. law,
including the
Foreign Corrupt
Practices Act (FCPA)

Investments in
bribes and
political
contributions
not allowed
under U.S. law,
including the
Foreign Corrupt
Practices Act (FCPA)

I contend that
large corporate
investment in
political power is
sometimes the main
intangible asset of
the company.
This varies by
industry, but
political favors are
essential in
agribusiness,
pharmaceuticals,
energy, and various
other industries
subject to
government
regulation and
subsidies.
Enron took this type
of investment to an
extreme in both the
U.S. and in many
foreign nations.
Many of Enron's
investments in
political favors
appear to violate
the FCPA, but the
FCPA is so poorly
enforced that it
seldom prevents huge
bribes and other
types of investments
in political
intangibles.

I provide you
with several
examples below.

Two
Examples of
Enron's Lost
Millions in
Political
Intangibles

India
and
Mozambique:
Enron
Invests in
U.S.
Government
Threats to
Cut Off
Foreign
Aid

In
early
1995,
the
world's
biggest
natural
gas
company
began
clearing
ground
100
miles
south
of
Bombay,
India
for
a
$2.8
billion,
gas-fired
power
plant
--
the
largest
single
foreign
investment
in
India.

Villagers
claimed
that
the
power
plant
was
overpriced
and
that
its
effluent
would
destroy
their
fisheries
and
coconut
and
mango
trees.
One
villager
opposing
Enron
put
it
succinctly,
"Why
not
remove
them
before
they
remove
us?"

As
Pratap
Chatterjee
reported
["Enron
Deal
Blows
a
Fuse,"
Multinational
Monitor,
July/August
1995],
hundreds
of
villagers
stormed
the
site
that
was
being
prepared
for
Enron's
2,015-megawatt
plant
in
May
1995,
injuring
numerous
construction
workers
and
three
foreign
advisers.

After
winning
Maharashtra
state
elections,
the
conservative
nationalistic
Bharatiya
Janata
Party
canceled
the
deal,
sending
shock
waves
through
Western
businesses
with
investments
in
India.

Maharashtra
officials
said
they
acted
to
prevent
the
Houston,
Texas-based
company
from
making
huge
profits
off
"the
backs
of
India's
poor."
New
Delhi's
Hindustan
Times
editorialized
in
June
1995,
"It
is
time
the
West
realized
that
India
is
not
a
banana
republic
which
has
to
dance
to
the
tune
of
multinationals."

Enron
officials
are
not
so
sure.
Hoping
to
convert
the
cancellation
into
a
temporary
setback,
the
company
launched
an
all-out
campaign
to
get
the
deal
back
on
track.
In
late
November
1995,
the
campaign
was
showing
signs
of
success,
although
progress
was
taking
a
toll
on
the
handsome
rate
of
return
that
Enron
landed
in
the
first
deal.
In
India,
Enron
is
now
being
scrutinized
by
the
public,
which
is
demanding
contracts
reflecting
market
rates.
But
it's
a
big
world.

In
November
1995,
the
company
announced
that
it
has
signed
a
$700
million
deal
to
build
a
gas
pipeline
from
Mozambique
to
South
Africa.
The
pipeline
will
service
Mozambique's
Pande
gas
field,
which
will
produce
an
estimated
two
trillion
cubic
feet
of
gas.

The
deal,
in
which
Enron
beat
out
South
Africa's
state
petroleum
company
Sasol,
sparked
controversy
in
Africa
following
reports
that
the
Clinton
administration,
including
the
U.S.
Agency
for
International
Development,
the
U.S.
Embassy
and
even
National
Security
adviser
Anthony
Lake,
lobbied
Mozambique
on
behalf
of
Enron.

"There
were
outright
threats
to
withhold
development
funds
if
we
didn't
sign,
and
sign
soon,"
John
Kachamila,
Mozambique's
natural
resources
minister,
told
the
Houston
Chronicle.
Enron
spokesperson
Diane
Bazelides
declined
to
comment
on
the
these
allegations,
but
said
that
the
U.S.
government
had
been
"helpful
as
it
always
is
with
American
companies."
Spokesperson
Carol
Hensley
declined
to
respond
to
a
hypothetical
question
about
whether
or
not
Enron
would
approve
of
U.S.
government
threats
to
cut
off
aid
to
a
developing
nation
if
the
country
did
not
sign
an
Enron
deal.

Enron
has
been
repeatedly
criticized
for
relying
on
political
clout
rather
than
low
bids
to
win
contracts.
Political
heavyweights
that
Enron
has
engaged
on
its
behalf
include
former
U.S.
Secretary
of
State
James
Baker,
former
U.S.
Commerce
Secretary
Robert
Mosbacher
and
retired
General
Thomas
Kelly,
U.S.
chief
of
operations
in
the
1990
Gulf
War.
Enron's
Board
includes
former
Commodities
Futures
Trading
Commission
Chair
Wendy
Gramm
(wife
of
presidential
hopeful
Senator
Phil
Gramm,
R-Texas),
former
U.S.
Deputy
Treasury
Secretary
Charles
Walker
and
John
Wakeham,
leader
of
the
House
of
Lords
and
former
U.K.
Energy
Secretary.

United
States
Deregulation
of Energy
That
Needed a
Change in
the Law:
Enron's
Investment
in Wendy
Gramm

I
watched
your
Sunday
morning
appearance
on
Face
the
Nation
with
intense
interest.
Inasmuch
as
I
own
a
fair
amount
of
Enron
stock
in
my
SEP/IRA,
I'm
sure
you
can
understand
my
curiosity
relative
to
your
investigation.

Knowing
you
to
be
an
honorable
man,
I
feel
secure
that
you
will
diligently
pursue
the
below
listed
matters
in
an
effort
to
determine
what
part,
if
any,
these
matters
contributed
to
the
collapse
of
Enron.

1.
Government
records
reveal
the
awarding
of
seats
to
Enron
executives
and
Ken
Lay
on
four
Energy
Department
trade
missions
and
seven
Commerce
Department
trade
trips
during
the
Clinton
administration's
eight
years.

a.
From
January
13,
1995
through
June
1996,
Clinton
Commerce
Secretary
Ron
Brown
and
White
House
Counsel
Mack
McLarty
assisted
Ken
Lay
in
closing
a
$3
billion
dollar
power
plant
deal
with
India.
Four
days
before
India
gave
final
approval
to
the
deal,
Enron
gave
$100,000
to
the
DNC.
Any
quid
pro
quo?

b.
Clinton
National
Security
Advisor,
Anthony
Lake,
threatened
to
withhold
aid
to
Mozambique
if
it
didn't
approve
an
Enron
pipeline
project.
Subsequent
to
Mr.
Lake's
threats,
Mozambique
approved
the
project,
which
resulted
in
a
further
$770
million
dollar
electric
power
contract
with
Enron.
Perhaps,
if
NSA
Advisor
Lake
had
not
been
so
busy
strong-arming
for
Enron,
he
might
have
been
focused
on
something
obliquely
related
to
national
security
like,
say,
Mr.
Bin
Laden?
Could
it
be
that
a
different,
somewhat
related,
investigation
is
warranted?

c.
In
1999,
Clinton
Energy
Secretary
Bill
Richardson
traveled
to
Nigeria
and
helped
arrange
a
joint,
varied,
energy
development
program
which
resulted
in
$882
million
in
power
contracts
for
Enron
from
Nigeria.
Perhaps
if
Energy
Scretary
Richardson
had
been
more
focused
on
domestic
energy,
we
might
have
avoided:

i.
The
severe
loss
of
nuclear
secrets
to
China
and
concurrently
ii.
developed
more
domestic
sources
of
energy.

d.
Subsequent
to
leaving
Clinton
White
House
employ,
Enron
hired
Mack
McLarty
(White
House
Counsel),
Betsy
Moler
(Deputy
Energy
Secretary)
and
Linda
Robertson
(Treasury
Official).
Even
a
person
without
a
high
school
diploma
(no
disrespect
to
airline
security
screeners)
can
see
that
this
looks
like
Enron
paying
off
political
favors
with
fat-cat
corporate
jobs,
at
the
expense
of
stockholders
and
Enron
pension
employees.

e.
Democratic
Mayor
Lee
P.
Brown
of
Houston
(Enron
headquarter
city),
received
$250,000
just
before
Enron
filed
Chapter
11
bankruptcy.
Isn't
that
an
awful
lot
of
money
to
throw
away
right
before
bankruptcy?

The
Democratic
National
Committee
was
the
recipient
of
hundreds
of
thousands
of
dollars
from
1990
through
2000.
The
above
matters
appear
to
be
very
troubling
and
look
like,
smack
of,
reek
of,
political
favors
for
campaign
payoffs.
I
know
you
will
find
out.

2.
Recently,
former
Clinton
Treasury
Secretary
Robert
Rubin
called
a
top
U.
S.
Treasury
official,
asking
on
Enron's
behalf,
for
government
help
with
credit
agencies.
As
you
well
know,
Rubin
is
the
chairman
of
executive
committee
at
Citigroup,
which
just
coincidentally,
is
Enron's
largest
unsecured
creditor
at
an
estimated
$3
billion
dollars.

3.
As
you
well
know,
Mr.
Leiberman,
Citigroup
is
Senator
Tom
Daschle's
largest
contributor
($50,000)
in
addition
to
being
your
single
largest
contributor
($112,546).
This
fact
brings
to
mind
some
disturbing
questions
I
feel
you
must
answer.

a.
Have
you,
any
member
of
your
staff,
any
Senate
or
House
colleagues,
any
relatives
or
any
friends
of
yours,
been
asked
by
Citigroup
to
intercede
on
their
behalf,
in
an
effort
to
recover
part
or
all
of
Citigroup's
$3
billion,
at
the
expense
of
Enron's
shareholders,
employees
and
or
Enron
pensioners?

b.
Did
your
largest
contributor,
Citigroup,
have
anything
to
do
with
the
collapse
of
Enron?

c.
Enron
has
tens
of
thousands
of
employees,
stockholders
and
pensioners
who
have
lost
their
life
savings.
How
will
you
answer
their
most
obvious
question?
Do
you
represent
Citigroup,
your
largest
contributor,
or
do
you
represent
the
Enron
employees,
et
al,
who
stand
to
lose
if
Citigroup
recovers
any
of
its
$3
billion?

During
Sunday's
Face
the
Nation,
both
you
and
Senator
McCain
praised
Attorney
General
Ashcroft
for
recusing
himself
from
the
Justice
Department
investigation
because
he
had
once
received
a
contribution
from
Enron.
I
know
in
my
heart,
that,
being
the
honest
gentleman
you
are,
you
will
now
recuse
yourself
because
of
the
glaring
conflict
of
interest
described
above.
I
also
know
that
you
will
pass
this
letter
to
your
successor
for
his
or
her
attention.

The extent to which
Enron's investments
and alleged
investments in current
and future political
favors actually
resulted in political
favors will never be
known. Clearly,
Enron invested in some
enormous projects such
as the $3 billion
power plant in India
knowing full well that
the investment would
be a total loss
without Indian
taxpayer subsidies.
Industry in India just
could not pay the
forward contract gas
rates needed to run
the plant.

Enron executives
intended that
purchased political
influence would make
it one of the largest
and most profitable
companies in the
world. In the
case of India, the
power plant became a
total loss, because
the tragedy of the
September 11 terror
made the U.S.
dependent upon India
in its war against the
Taliban. Even if
the White House
leaders had been
inclined to muscle the
Indian government to
subsidize power
generated from the new
Enron plant in India,
the September 11
tragedy destroyed
Enron's investment in
political intangibles
and its hopes to fire
up its $3 billion
gas-fired power plant
in India. The
White House had
greater immediate need
for India's full
support in the war
against the Taliban.

The point here is
not whether Enron
money spent for
political favors did
or did not actually
result in favors.
The point is that to
the extent that any
company or wealthy
employees invest
heavily for future
political favors, they
have invested in an
intangible asset and
have taken on the
intangible risk of
loss of reputation and
money if some of these
investments become
discovered and
publicized in the
media. In fact,
discovery and
disclosure will set
government officials
scurrying to avoid
being linked to
political payoffs.

Enron is a prime
example of a major
corporation focused
almost entirely upon
turning political
favors into revenues,
especially in the
areas of energy
trading and foreign
power plant
construction. As
such, these
investments are
extremely high risk.

It is doubtful that
political intangibles
will ever be disclosed
or accounted for
except in the case of
bankruptcy or other
media frenzies like
the Enron media
frenzies.

Question:
Accountants and
auditors face an
enormous task of
disclosing and
accounting for
political intangibles.

Answer:
Because disclosures
and accounting of
political intangibles
will likely destroy
their value.
Generally, accounting
for assets does not
destroy those assets.
This is not the case
for many types of
political intangibles
that cost millions
upon millions of
dollars in
corporations.

<<Question:
Accountants and
auditors face an
enormous task of
disclosing and
accounting for
political
intangibles.

Answer:
Because disclosures
and accounting of
political
intangibles will
likely destroy their
value. Generally,
accounting for
assets does not
destroy those
assets. This is not
the case for many
types of political
intangibles that
cost millions upon
millions of dollars
in
corporations.>>

Interesting.
There are many
instances where the
reverse is true --
the marketing value
to a lobbying firm
of having made large
contributions to the
winning candidates
(of whatever party)
is greatest where it
is well known. This
applies regardless
whether the
contributions came
from individual
partners or (at
least in those
states where it's
legal for state and
local elections)
from the firm
itself.

Even
on a local level, if
you're in a
jurisdiction where
judges are elected,
would you prefer to
go to a lawyer who
contributed to the
successful judge or
to one who did not?
I have a friend who
asks this question
directly whenever
he's seeking local
counsel. And if
you're that lawyer,
do you want that
contribution to be
secret or as public
as possible? Maybe
even exaggerated?

Dita
Beard is a classic
example -- her
initial
"puffery"
[whether truthful,
partially truthful,
or entirely false]
about getting the
IT&T antitrust
case dropped based
on a pledge of
IT&T funding to
support moving the
1972 Republican
National Convention
to Miami was a
marketing aid to her
ONLY if she let it
be known, at least
to her clients and
potential clients.

Similarly,
Ed Rollins writes of
a foreign
"contributor"
who apparently
passed a million in
cash to a middleman
and thought it made
it to the Reagan
re-election
campaign. Rollins
believes the
middleman (an
unnamed Washington
lawyer, by the way)
held on to it all
but the
"contributor"
felt he'd purchased
access, and
certainly the
middleman benefited
not just financially
but also from the
contributor's belief
that the middleman
had provided direct
access to the
campaign and hence
the Administration.

I
express no opinion
on how such things
should be recorded
in financial
statements -- I'm
just pointing out
that publicity about
large political
contributions to
successful
candidates (whether
within or exceeding
legal limits) can be
positive for some
businesses, such as
lobbying firms.

Craig
[Craig Polhemus,
Association Vitality
International]

August
28, 2002 reply from
Bob Jensen

Great
to hear from you
Craig.

I
agree that sometimes
the accounting and/or
media disclosure of
investments in
political favors may
increase the value of
those investments. Or
it may have a neutral
effect in some
industries like
agribusiness and oil
where the public has
come to expect that
members of Congress
and/or the Senate are
heavily dependent upon
those industries for
election to office and
maintenance of their
power.

On
the other hand, it is
unlikely that
accounting and media
disclosure of the
Enron investments in
political favors,
including the favors
of linking foreign aid
payments to Enron's
business deals, would
have either a positive
or neutral impact upon
the expected value of
those political favors
to Enron.

It
is most certain that
accounting and media
disclosure political
investments that are
likely to violate the
Foreign Corrupt
Practices Act would
deal a severe blow to
the value of those
intangible assets.

Bob
wrote:
<<On the other
hand, it is unlikely
that accounting and
media disclosure of
the Enron investments
in political favors,
including the favors
of linking foreign aid
payments to Enron's
business deals, would
have either a positive
or neutral impact upon
the expected value of
those political favors
to Enron.>>

I
tend to disagree on
this point. When a
questionable campaign
contribution is
disclosed, the
recipient politician
(if not a lame duck)
often seeks ways to
publicly demonstrate
independence by
opposing the donor's
desired legislative
positions.

Term
limits for elected
officials can kill
this positive effect
of sunshine, however
-- once you're a lame
duck, there's little
harm in doing favors
for your friends,
unless you intend to
run for some other
office. Similarly, I
am concerned that
mandatory rotation of
auditors simply sets a
clear time limit on
when they need to
"cash in" or
to develop a
"positive"
[e.g., lenient]
reputation among the
future clients they're
going to need
(assuming they are not
seeking only those
clients who value high
quality of earnings).

Let
me emphasize that, as
I was trained as an
economist and lawyer,
I am referring simply
to the incentives
built into the
rotation/term limit
system rather than to
the expected behavior
of auditors. (Also,
applying the mandated
rotation only to
individuals rather
than firms greatly
mitigates this risk.)

I
have great respect for
the professionalism of
real auditors, since
in government I also
had to deal with
separately elected
officials, almost
invariably from the
opposite political
party, whose audits,
usually timed for
election years, often
seemed to start with
the draft press
release and then seek
"evidence"
to back it up.
("If every county
spent less than the
median, then 10,000
more units of service
could have been
delivered" -- you
don't need to gather
ANY evidence to
determine that you
could buy more of
anything if all costs
were less than the
current median! And
the fact that they
might be comparing
fixed-route
transportation in
urban counties with
door-to-door
transportation for
medical appointments
for impaired clients
only in rural counties
didn't influence their
conclusions -- after
all, a "unit of
service" is a
"unit of
service", isn't
it?) In contrast, the
federally mandated
single state audits by
CPA firms were
substantive rather
than political
activities and we
welcomed them
accordingly

Craig

August
29, 2002 reply from
Bob Jensen

Hi
Craig,

I
agree to a point.
Certainly I think Phil
Gramm, as a lame duck
Senator, provided huge
political favors through
his wife Wendy, to Enron
in various ways and most
especially in the
deregulation of energy
markets such that Enron
became the world's
largest energy market
trader. Whether or not
he would have been so
openly blatant if he
were not a lame duck is
an interesting question.
I think the answer is
yes, but you will
probably argue no.

However,
in the more numerous
political favors sought
by Enron in other
countries, I don't think
the lame duck thing is
the issue. Mere
disclosure of bribes to
foreign officials
subjects corporations to
risk under the Foreign
Corrupt Practices Act.
Mere disclosure that
foreign aid will be shut
down and people will be
allowed to starve if
foreign governments to
now provide huge favors
to selected U.S.
corporations will
probably sink those
political favors and
make the government
agencies disavow any
link between themselves
and deal making of
corporations. Hence,
corporations must
operate in secret when
resorting to these types
of political favors such
as those sought by Enron
that are discussed at http://www.trinity.edu/rjensen/fraud.htm#bribes

I
still stand by my
argument that accounting
for investments in most
political intangibles
will destroy the value
of those intangibles.
Most political
intangibles are like
mushrooms that lose
their value if they must
grow in sunlight.

I
think companies have
invested a great
deal in political
intangibles outside
the arena of
government. Consider
the current
discussions on the
importance of
expensing stock
option expensing as
an example. Views
are strong and vary
widely on the issue
but clearly, these
positions exist only
to gain visibility
and increase
political pressure.

On
the side that
believes CPA stands
for 'can't prove
anything' we find
the speech to the
Stanford Director's
College on June 3,
2002 by T. J.
Rodgers, CEO of
Cypress. Mr. Rodgers
refers to expensing
options as
"...the next
mistake..." and
refers to
"...accounting
theology vs.
business
reality...." He
opposes the Levin-
McCain proposal and
recounts the story
you have on your
website of the 1994
political storm in
Silicon Valley when
the FASB proposed
expensing options.
He believes that the
free market will
eliminate any abuse
of option
accounting. Contrast
that with the
opposition
represented in the
July 24, 2002 letter
to CEOs from John
Biggs at TIAA-CREF.
Mr. Biggs also
derides the
profession by
labeling APB 25 as
an "...archaic
method..." and
that its use has the
effect of “…eroding
the quality of
earnings…” by
encouraging “…the
use of one form of
compensation.” Mr.
Biggs completes his
letter by equating
option expensing to
management
credibility. Both of
these men have made
political
investments with
their comments,
drawing lines in the
sand. While the
remarks were not
made directly to any
political body, and
there is no tangible
cost involved, this
is still political
pressure. It is also
interesting both men
focus on the
accounting
profession as the
root cause rather
than the value of
the political
intangibles that
exist only in market
capitalization.

Consider
how companies build
political
intangibles with
analysts,
institutional
shareholders and
others. ADP had an
extended string of
increased quarterly
earnings – over
100 consecutive
quarters. The PE
multiple for the
stock has been high
for some time, due
in no small part to
the consistency of
this trend. ADP
management reminded
shareholders with
every quarter how
long they had
provided
shareholders with
higher earnings.
When that streak
recently ended, the
stock dropped like a
stone. Closing price
moved down from
$41.35 on July 17,
2002 to $31.60 the
next day. The volume
associated with that
change was almost
nine times the July
16 trading volume.
How would anyone
explain this event
other than a
reversal of
political
intangibles that did
not exist on the
financial
statements?

Power
and politics are
always with us. We
just have to be
smart enough to know
which is for show
and which is for
$$$. (By the way, if
you have a way to
tell them apart, let
me know.)

Hi,
Bob and Craig!
You've discovered an
accounting
application of
Heisenberg's
uncertainty
principle, which
originated with the
notion that to
"see" an
electron's position
we have to
"illuminate"
it, which causes it
to shift its
position so it's not
"there"
any more. To quote
from the American
Institute of Physics
( http://www.aip.org/history/heisenberg/p08b.htm
), "At the
moment the light is
diffracted by the
electron into the
microscope lens, the
electron is thrust
to the right."

When
we
"illuminate"
political
intangibles by
disclosing them,
they are not
"there"
any more.

There
is an extensive
literature on the
economics of
information. The
Analytics of Uncertainty
and Information by Jack
Hirshleifer and John
Riley is a good survey.
Chapters 6 (The
economics of emergent
public information) and
7 (Research and
invention) address the
issues of the value of
private information and
the effects of
disclosure on its value.

Heisenberg's
uncertainty principle
both
"originated"
and (for practical
purposes) terminated
with the behavior of
electrons and other
sub-atomic particles. It
applies to the joint
indeterminacy of the
position and momentum of
electrons. It is only
significant at the
atomic level because
Planck's constant is so
small.

I
love
"popular"
versions of quantum
physics books. This
started when, in my
favorite Italian
restaurant in Albany,
I found the kitchen
cleanup staff reading
"In Search of
Schrodinger's
Cat" by John
Gribbin. (If you're
ever in Albany -- eh,
Jagdish? -- check it
out: Cafe Capriccio on
Grand Street, run by
the only Renaissance
man I've ever known,
Jim Rua -- perhaps
this explains why he
hired intellectual
kitchen staff.)
Anyway, I can't put my
hands on that book
just now but here are
two quotes ("fair
use," I hope)
from Gribbin's sequel,
"Schrodinger's
Kittens and the Search
for Reality":

A)
About the
"classical form
of quantum
theory" (an
oxymoron if I ever
heard one) --
"Heisenberg said:
'The Copenhagen
Interpretation regards
things and processes
which are describable
in terms of classical
concepts, i.e. the
actual, as the
foundation of any
physical
interpretation.' In
other words, the atoms
of which everything in
the classical world is
made are somehow less
real than the things
atoms are made into!
This struck many
people as downright
weird even in the
1930s; it is even
harder to swallow now
that atoms have been
photographed."

B)
About the Heisenberg
principle itself:
"This
complimentary, or
wave-particle duality
[of light or other
forms of
electromagnetic
radiation], is related
to the famous
uncertainty principle
discovered by
Heisenberg. The
simplest version of
this principle tells
us that it is
impossible to measure
both the position and
the momentum of a
quantum object at the
same time. Momentum is
simply a measure of
where such an object
is going, and how
fast. It is, in many
ways, a wave property
-- as a wave by nature
is spread out, whereas
a particle is confined
in one place. We can
make measurements
which observe the
position of an
electron, or we can
make measurements
which tell us which
way it is moving, and
in either case we can
make the measurements
as accurate as we
like. But trying to
measure the position
very accurately blurs
the electron's
momentum, by a
quantifiable amount,
and vice versa.
"This is not, as
some textbooks still
mistakenly suggest,
solely a result of the
practical difficulty
of making
measurements. It is
not simply because in
measuring the position
of the electron
(perhaps by bouncing
photons off it) we
give it a kick, which
changes its momentum.
A quantum object DOES
NOT HAVE a precisely
defined momentum and a
precisely defined
position. The electron
itself does not 'know'
within certain limits
where it is or where
it is going.
Exaggerating only
slightly, if it knows
exactly where it is,
it doesn't know where
it is going at all; if
it knows exactly where
it is going, it
doesn't have the
faintest idea where it
is. Usually, though, a
quantum object has an
approximate idea of
both where it is and
where it is going. But
the important word
here is 'approximate';
hard though it is to
understand from the
'common-sense'
viewpoint of our
everyday world, the
quantum entity cannot
be pinned down to a
definite location, and
there is always some
uncertainty about
where it is going.
"This is
crucially important,
for example, in
nuclear fusion
reactions, where the
quantum uncertainty
allows nuclei that are
not close enough to
touch one another,
according to the ideas
of classical physics,
to overlap with one
another and combine.
Some of these nuclear
reactions are what
keep stars hot.
Without quantum
uncertainty, the Sun
would not shine the
way it does."

In
addition to Gribbin's
two books, there are
fascinating
discussions of this
concept in Stephen
Hawking's famous book,
"A Brief History
of Time," and in
Richard Feynman's
classic "Lectures
on Physics" [the
popular version of
which has just been
re-released as a dual
volume starting from
one end as "Five
Easy Pieces" and
from the other as
"Five Not So Easy
Pieces"]. All of
these are on my
bookshelves somewhere,
in case you need
publication data, etc.

I
have managed to trap
both my sons into a
similar fascination
with these concepts,
especially the
eleven-year-old. (Once
they outgrew Mobius
strips and Klein
bottles, quantum
theory seemed the next
best puzzle.) If the
eleven-year-old were
awake I'd ask for his
version, which might
be easier to
understand than
Gribbin's! (By the
way, Gribbin also
says, "the
equations of
relativity theory do
not rule out the
possibility of
entities that travel
backwards in
time." But that's
probably a topic for
another listserve.)

Should
we ask Yuji Ijiri if
he uses quantum
accounting theory in
"Triple-Entry
Bookkeeping and Income
Momentum"?

Craig
[Craig Polhemus,
Association Vitality
International]

Enron had 43 subsidiaries claiming Mauritius was
their home base. Where in the heck is Mauritius?

In the Enron and related scandals, all eyes are focused upon how investors
got ripped off. All along taxpayers were also getting ripped off in a
number of ways, and especially this was the case of corporate income tax.
The corporate income tax as a proportion of total government revenues has been
shrinking annually due to corporate lobbying efforts to build in
loopholes. One of the biggest loopholes is to move corporate headquarters
offshore to places like Bermuda. Enron found even a really obscure place
to declare as headquarters for 43 subsidiary corporations.

When you think of Enron, you
think of Houston. You probably don't think of Mauritius, a tiny island
republic off the east coast of Africa whose chief export is sugarcane.
But Enron was a major presence there, at least on paper. By the
beginning of 2000, the energy company had no fewer than 43 subsidiaries in
Mauritius--quite a presence in a country with a population one-fifth that of
metropolitan Houston.

Why was Enron doing so much
business on an island in the Indian Ocean? Taxes. Avoiding them.
Enron may have failed as an energy company--it went spectacularly bankrupt
earlier this year--but its accountants were masters at dodging the IRS.
Enron paid no federal income taxes for four out of the past five years.

How did Enron pull this off?
In part, by doing what many American companies have done: registering abroad.
Individuals pay income taxes on what they earn, no matter where they earn it.
Corporations play by different rules. They pay federal income taxes only
on money that enters the United States. In other words, if your
Mauritius-based company earns $10 million, and that money never comes back to
the United States, you don't pay taxes on it. It's a nifty deal if
you're a corporation, infuriating if you're an ordinary taxpayer. Over
the next ten years, tax-dodging companies are expected to cost the U.S.
Treasury $6 billion--money that will have to come out of your pocket and mine.

Don't be surprised if companies
stiff Uncle Sam even worse. Countries that 15 years ago hosted far more cruise
ships than corporations--Aruba, Barbados, the Bahamas, Bermuda--are now the
legal home to a growing share of American industry. The lightly taxed
Cayman Islands have become so popular with American companies that it is now
the fifth largest financial center in the world.

And it's no longer just about
re-incorporating overseas. Companies are also registering patents and
trademarks in island hideaways, a clever way to keep royalties tax-free.

All this at a time when the
United States is straining its treasury to fight a war against terrorism.
Republican Senator Chuck Grassley of Kansas calls foreign tax havens an
example of "profit over patriotism." He's right. But
it's worse than that. Not only does offshore tax dodging hurt the United
States, it often hurts the very shareholders it's supposed to benefit.

Consider the case of The
Stanley Works corporation. Earlier this year, Stanley's shareholders
voted to relocate the company's headquarters to Bermuda, joining fellow
toolmaker Cooper Industries, and a number of other established American
companies that have done the same in recent years. Shareholders made
their decision largely on predictions by Stanley CEO John M. Trani, who said
that a move to Bermuda would save the company $30 million in annual taxes and
boost the stock price 11.5 percent during the first year alone.

Trani's projections may be
right. And for him, that would be good news. His stock options
alone would increase in value by $17.5 million in a single year. Add a
higher salary, bonuses, a retirement package, and Trani's profit from the
relocation could eventually total $385 million.

Meanwhile, many investors would
initially get the shaft, in the form of capital gains taxes they would pay
when the company leaves the country. The New York Times
calculated that even if Stanley's stock price goes as high as Trani says it
will, these shareholders "will barely break even after taxes."
As for the government, it would lose $240 million in corporate income taxes
from Stanley over the next eight years.

August 21 reply from George Lan (University of
Windsor) --- George Lan [glan@UWINDSOR.CA]

I happen to be from Mauritius, a tropical island in
the Indian Ocean (a couple of hundred miles off the big island of Madagascar).
Mark Twain once said that "God created Mauritius first and made a copy
for Paradise." Mauritius is also the land of the legend of Paul and
Virginie (written in a book by Bernandin de Saint Pierre) and is famous for a
rare English stamp. It's main claim to fame (up tro now) is that it was the
land of the dodo bird. (It is extinct because it could not fly--the big birds
did not have to fly because there were no humans on the island until the Dutch
settlers came and started shooting them for fun). It seems that Enron has gone
the way of the dodo!

George Lan
Born in Port-Louis, Mauritius

August 28, 2001

A federal grand jury has
indicted Scott Sullivan,
WorldCom's former top
finance executive, on
charges of conspiring to
commit securities fraud,
securities fraud and making
false filings with the SEC.
Also indicted was Buford
Yates, a former accounting
executive.

The Sarbanes-Oxley Act is complicated,
confusing and open to interpretation. To help companies set priorities, experts
point to four major changes that take effect this month. http://www.accountingweb.com/item/88823

CEO/CFO
certification.
Effective August 29,
2002, the chief
executive officers and
chief financial
officers of all
companies that are
required to file
periodic reports with
the Securities and
Exchange Commission
(SEC) must personally
certify that their
quarterly and annual
reports are both
accurate and complete.
The SEC issued a proposed
rule that would
cover this
requirement.

Loans
to directors and
officers. SEC
registrants are
prohibited from making
many types of personal
loans to their
directors and
executive officers.
This ban was effective
on enactment of the
law. Loans made prior
to that date were
grandfathered, but
these loans cannot be
modified or renewed.
It is not yet clear
whether the ban
applies to employee
benefits that can be
construed as loans,
(e.g., broker-assisted
loans used when
executives exercise
stock options). The
SEC is expected to
clarify the
requirements in the
coming weeks.

Insider
trading reports.
Effective August 29,
2002, corporate
insiders (directors,
executive officers,
and greater-than-10
percent beneficial
owners) of U.S. public
companies must file
reports of
transactions in the
companies' securities
by the second day
after the execution of
the transaction. The
SEC issued supplemental
information that
clarifies this
requirement.

Whistle-blower
protection.
Effective on
enactment, employees
who provide
information regarding
conduct that the
employee reasonably
believes violates U.S.
securities or
anti-fraud laws are
protected from
retaliatory actions,
including termination
of employment.
Companies may want to
review their personnel
policies to see if
they need to be
revised in light of
the new law.

Question:
How are leading business schools changing course content and curricula in the
wake of the recent accounting, finance, and corporate governance scandals?

CASE WESTERN RESERVE UNIVERSITYBusiness Ethics
Part 1: The Short Road From Unbelievable Success to Unmitigated Disaster
Part 2: Enron 101
"The class features a discussion of how Ken Lay became addicted to
success. Students must write an ethical analysis of what went wrong at Enron
using either an Aristotelian or a Kantian framework."

UNIVERSITY OF PENNSYLVANIAEthics and Management
"[The class] does not attempt to convert sinners to saints, preach
absolute truths, or deter the morally vulnerable."

NEW YORK UNIVERSITYProfessional Responsibility
From a session called "Truth and Disclosure": "Exaggeration
and bluffing are...part of the business game, but how much is too
much?"

UNIVERSITY OF CALIFORNIA AT IRVINEThe Enron Case
"One of the classes will be a lecture by [Sherron Watkins]." The
alumni network will be funding an overflow room.

NORTHEASTERN UNIVERSITYFraud: The Dark Side of Business
"Topics include legal aspects of fraud, Ponzi and pyramid
schemes."

PEPPERDINE UNIVERSITYEthics and Law for Executives
"For the past ten years, 2% of students attending the three-day course
have quit their jobs within seven days, citing ethical reasons."

HARVARD UNIVERSITYThe Moral Leader
"This course relies heavily on works of fiction, including Macbeth,
The Secret Sharer, The Last Tycoon, Remains of the Day,
and I Come as a Thief, to examine in-depth the practical moral issues
that managers face."

UNIVERSITY OF TEXAS AT AUSTINManagement of Auditing and Control
One session has been titled "Executive Compensation: Is Jail Time
Necessary?" Another session delves into Anatomy of Greed: The
Unshredded Truth From an Enron Insider, which was penned by a University of
Texas alum.

UNIVERSITY OF MARYLANDBusiness Ethics (Spring 2003)
"A visit to a federal prison provides a unique opportunity to speak
with former-executives-turned-inmates about the serious consequences of
compromising ethical standards."

Cleveland, OH,
August 16, 2002 - James E. Copeland, Jr., the chief executive of Deloitte
& Touche and its global organization, Deloitte Touche Tohmatsu, today
discussed the importance of assets such as individual integrity to
rebuilding public confidence in the U.S. financial system.

In a speech today
at The City Club of Cleveland, a leading forum for public debate and
discussion, Copeland said everyone who leads institutions needs to find ways
to influence and encourage ethical, competent behavior.

He also made public
new Deloitte & Touche initiatives to build on internal practices that
engender high professional standards, and reiterated his call for creation
of a National Financial Review Board -- an independent body to probe the
causes of corporate failures.

"All leaders
in the capital markets have a responsibility to create a positive
expectation -- an expectation of ethical and technical excellence -- within
their organizations," said Copeland. "Our profession and our
firm must continually consider new ways that we can better protect the
public interest. When you see the pain associated with any audit
failure, it's clear we must do better -- and we will."

"We cannot and
should not accept risk that is the result of illegal activity, unethical
behavior or gross incompetence," he said. And while it is
necessary to prosecute and otherwise condemn the misconduct of the few,
Copeland stated it is equally necessary to demonstrate the incentives to act
ethically and earn the trust of the market.

New
Initiatives

The first measure
announced by Copeland is the deployment of Deloitte & Touche corporate
compliance and ethics services professionals to perform an extensive
self-examination of the firm. For more than 10 years, the firm has
helped clients establish or improve their ethics programs and ensure better
compliance. "Now, we're going to become our own client,"
Copeland said.

Specifically, these
professionals will assess the firm's opportunity to:

Improve the
ability of its people to recognize behaviors and environmental
characteristics that raise ethical issues, in client organizations and
within Deloitte & Touche, and to respond consistently and properly
every time.

Reexamine the
content of its professional education curriculum to make certain ethics
are sufficiently emphasized and our expectations properly communicated.

Second, in addition
to rotating the lead audit partner every five years, as required by new
legislation, Copeland said Deloitte & Touche will apply the five-year
partner rotation policy to all audit partners who are responsible for
auditing major international subsidiaries.

Similarly, he said
Deloitte & Touche will enact a policy of applying rotation requirements
to all professionals serving public audit clients in any capacity - even
those below the partner level.

"Ethics,
integrity and quality are the foundation of our culture," said Copeland
"We work very hard at applying those principles to the work we do on
behalf of the investing public and on behalf of the clients who've placed
their trust in us."

National
Financial Review Board

During the speech,
Copeland also shared his outline for the creation of an independent federal
agency, modeled on the National Transportation Safety Board, to investigate
major corporate failures. Staffed with skilled professionals, the
board would be tasked with performing reviews of each failure and issuing
detailed public reports on the causes.

"The scope of
the problems at Enron was first disclosed last October," he remarked.
"We are now nearing the end of the summer -- some 10 months later --
and we are still not sure exactly what caused the failure or how to prevent
the next one."

To advance the
concept, Deloitte & Touche assembled a team of professionals with deep
knowledge of auditing, forensic accounting, risk management and public
administration. Under Copeland's direction, the group will explore
specific potential models of how the agency could be structured, governed
and financed.

"Investors are
angry," he commented. "Investors also expect to understand
why so many business failures happened -- and what can be done to prevent
similar failures from happening again."

The proposed board
would not replace business investigatory roles performed by the Justice
Department, Congress or the SEC, but would work in concert with these
agencies and report to Congress on ways to avert future disasters.

The Panel's role is
to alert the nation to the immense social and economic damage caused by fraud
and help both public and private sectors to fight back. It is dedicated to a
holistic approach and the long view. The Panel works to:

originate
proposals to reform the law and public policy on fraud

develop proposals
to enhance the investigation and prosecution of fraud

advise business on
fraud prevention, detection and reporting

assist in
improving fraud related education and training in business and the
professions establish a more accurate picture of the extent, causes and
nature of fraud

Established in 1998
through a public spirited initiative by the Institute of Chartered Accountants
in England and Wales, the Panel exists to challenge complacency and supply
remedies.

The Panel is an
independent body of volunteers drawn from the law and accountancy, banking,
insurance, commerce, regulators, the police, government departments and public
agencies. It is not restricted by seeing the problem from any single point of
view but works to encourage a truly multi-disciplinary perspective. The Panel
is given a serious hearing as a consequence and has contributed to the new,
and more vigorous attitude in government towards fraud.

While many on Wall
Street are calling for an end to pro forma financial reporting given
widespread jitters over corporate clarity, it's clear from second-quarter
reports that the accounting practice is a hard habit to break.

Publicly traded
companies are required to report their results according to generally accepted
accounting principles, or GAAP, under which all types of business expenses are
deducted to arrive at the bottom line of a company's earnings report.

But an
ever-increasing number of companies in recent years has taken to also
reporting earnings on a pro forma – or "as if" – basis under
which they exclude various costs. Companies defend the practice, saying the
inclusion of one-time events don't accurately reflect true performance.

There is no universal
agreement on which expenses should be omitted from pro forma results, but pro
forma figures typically boost results.

Indeed, as the
second-quarter reporting season dwindles down with more than 90 percent of the
Standard & Poor's 500 companies having reported, only Yahoo Inc.,
Compuware Corp. and Xilinx Inc. made the switch to reporting earnings under
GAAP, according to Thomson First Call.

While a number of
S&P 500 companies, including Computer Associates International Inc. and
Corning Inc., made the switch to GAAP in the first quarter, that still brings
the number to 11 companies in total that have given up on pro forma over the
last two quarters.

"It's
disappointing that at this stage we haven't seen more companies make the
switch to GAAP earnings from pro forma," said Chuck Hill, director of
research at Thomson First Call.

Accountants are still licking their wounds from the
recent stream of corporate scandals and Arthur Andersen's collapse. Perhaps this
will speed up the healing process ...

A recent poll conducted by Date.com, an online dating
community, found that singles would prefer to date an accountant rather than
go out with the perennial butt of sarcastic jokes, the trial lawyer.

Furthermore, to show just how far accountants remain
from the bottom of the dating pool, they might be happy to learn they are
preferred as dates by a better than four-to-one margin over the lowly house
burglar.

We should point out that Date.com gave the survey
participants just three choices of occupations: house burglar, trial lawyer
and accountant.

Put into perspective, perhaps it's not such great
news after all!

As was pointed out in a recent cartoon in The New
Yorker, women/men are drawn to men/women who live on the edge of
danger. That explains the results in the above poll.